SMM News: in September 2016, the Bank of Japan introduced a "yield curve control" policy to control short-term interest rates at minus 0.1 per cent and keep 10-year bond yields near zero. This policy, unlike the central bank's traditional focus on short-term interest rates, is aimed at stabilizing long-term interest rates, which tend to have a more direct impact on consumer borrowing costs and consumer spending. Several central banks, including the Fed, have been asking the BoJ for details of the unconventional policy tool, according to people familiar with the matter.
In recent months, a number of senior Fed officials, including Brainard and Clarida, vice chairman, have talked about yield curve control policies. Although Brainard has not officially made it an option, she said she "would like to know more about this policy". Chicago Federal Reserve Bank President Evans also said that "open to a range of alternative policies."
Fed Governor Bernard Brainard mentioned the concept at a meeting in May. She said:
"once short-term interest rates fall to zero, we may turn our attention to slightly longer-term interest rate targets, such as the initial one-year rate, and perhaps to the two-year rate if the market needs more stimulus."
The increased interest of central banks in controlling the yield curve reflects the difficulties facing the world's three central banks. At present, only the Fed can reasonably raise interest rates from zero during the 2007-2009 financial crisis. Now, however, even the Fed is about to cut interest rates in response to a weak global economy and persistently depressed inflation.
Against a backdrop of increased risk in the global economy, the Federal Reserve, the Bank of Japan and the European Central Bank have all plunged into unconventional policies to fight the crisis. Each of these central banks has bought trillions of dollars in financial assets and plans to inject large amounts of cash into the economy through quantitative easing. While the effect of QE is controversial, markets believe the central bank is likely to do so in the future.
However, the BoJ has gone further than other central banks in implementing unconventional policies. Three years ago, with short-term interest rates pushed into negative interest rates with little effect, the BoJ decided to keep long-term interest rates close to zero in an effort to reinvigorate weak consumer spending.
Under the control of the yield curve, the central bank sets interest rate targets for a specific period and buys any amount of bonds needed to achieve that goal. Such goals are easy to communicate with the public, but also make it easier for businesses and households to plan their spending.
This approach, for all its good and bad, has achieved some results in Japan. The yield on the 10-year Japanese Treasury note is basically kept close to the target level. Retail sales in Japan have risen year-on-year in the past 31 months, except for one month, which has not been seen in Japan since the early 1990s.
However, inflation is far from meeting the BoJ's target of 2 per cent, and some fear that yield curve control is curbing rising inflation expectations. Kazuo Momma, an executive economist at the Mizuho Institute and a former BoJ executive, said: "the risk is that the central bank's restrictions on long-term interest rates could lower inflation expectations."
The prospect of a rate cut in the US has pushed down global bond yields, including Japan, which fell to-0.195 per cent last month, a nearly three-year low. An official familiar with the BoJ said:
"keeping bond yields negative for a long time means that the yield curve controlling (YCC) will face a real test."
In fact, the Fed tried something similar in 2011 and 2012. At that time, the Federal Reserve implemented a program called "Opera (10.66,-0.13,-1.20%) tion Twist"), which sold short-term bonds and bought long-term bonds. The plan pushed consumer borrowing costs, such as mortgages, to the lowest level in a generation, when inflation did rise.
Politically, however, it is challenging to set a clear target for long-term yields again, as it could rekindle concerns about excessive Fed and market intervention.
For the ECB, controlling the yield curve is even more impossible. Because there are no eurozone common bonds available for the ECB to buy, this means that the ECB must choose which of the 19 members of the eurozone to target bond yields. If the ECB tries to narrow or target spreads in different countries, it could be criticised by the markets for conniving at profligate government spending.
Analysts point out that the BoJ's huge influence in the Japanese government bond market is the key to the success of its policy. In an effort to stimulate economic growth, the BoJ has bought Japanese bonds heavily for years and now accounts for about 45 per cent of the bond market.
By contrast, the Fed's current holdings of US Treasuries account for only about 13 per cent of its $15.9 trillion of outstanding US Treasuries. A key factor for the Fed will be how much control it can or want to have over the Treasury market. Another Japanese official said:
The BoJ has huge control over the bond market. That is why yield curve control is a very powerful tool for the Bank of Japan. "
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